Got your wealth tied up in your own company?If you've built a company and have a majority of your personal net worth tied up in your own stock, you have a "concentrated equity position." That can be a blessing--but also a curse because you are subject to downward stock price swings and you may not be able to liquidate To pay and settle the amount of a debt; to convert assets to cash; to aggregate the assets of an insolvent enterprise and calculate its liabilities in order to settle with the debtors and the creditors and apportion the remaining assets, if any, among the stockholders or owners of the large portions of your holdings without causing concern for other investors. As a corporate insider, you may also be subject to "windows" or restrictions to follow when you want to sell the stock. Here are a few option-based alternatives to protect your wealth. First, you may want to consider selling covered equity call options, which generate a cash payment to the seller. If you are willing to sell your stock at a designated price, you can sell covered calls Covered Call Having a long position in an asset combined with a short position in a call option on the same underlying asset. Notes: This is considered to be one of the safest option positions. against your stock position. As the call seller, you receive a cash premium in exchange for accepting an obligation to sell the underlying stock at the designated strike price. If the stock's price is below the strike price at expiration EXPIRATION. Cessation; end. As, the expiration of, a lease, of a contract, or statute. 2. In general, the expiration of a contract puts an end to all the engagements of the parties, except to those which arise from the non- fulfillment of obligations created , the call will most likely expire worthless and the premium you received enhances your overall return on the stock. Though short equity options can be assigned any time prior to expiration, if the stock price is above the strike price at expiration, with a standard listed option Listed option An option that has been accepted for trading on an exchange. , your call option will likely be assigned and you are obligated ob·li·gate tr.v. ob·li·gat·ed, ob·li·gat·ing, ob·li·gates 1. To bind, compel, or constrain by a social, legal, or moral tie. See Synonyms at force. 2. To cause to be grateful or indebted; oblige. to sell your stock at the strike price. Simply put, in exchange for an upfront cash premium, you surrender your participation in the stock's price appreciation beyond the strike price. Thus, your upside potential Upside potential The amount by which analysts or investors expect the price of a security may increase. upside potential The potential price or gain that may be expected in a security or in a security average, generally stated as the dollar is limited. Selling covered equity call options is probably most appropriate for investors who can and will sell their stock at the option's strike price and who want the opportunity to enhance their income from a stock position. Another strategy is buying a put option to protect an existing stock position, which is like buying downside Downside The dollar amount by which the market or a stock has the potential to fall. Notes: You might hear someone say that the downside on stock XYZ is $10. What that means is that the stock could fall by this amount if things got bad. price insurance. As the put buyer, you pay the seller an up-front cash premium to set a minimum value for the underlying stock. The strike price of the put establishes a floor for the value of the underlying stock. If the price of the stock is above the strike price at expiration, the put expires worthless and the premium you paid for the put is lost and becomes your cost of the insurance. If the price of the stock is below the put strike, you have the option, but not the obligation, of selling your stock to the put seller at the strike price. Buying protective put options provides a way to absolutely limit your downside risk Downside Risk An estimation of a security's potential to suffer a decline in price if the market conditions turn bad. Notes: You can think of this as an estimate of the amount that you could lose on a stock or other investment. on a stock for the length of the contract in exchange for payment of an up-front cash premium. Buying protective put options is usually most appropriate for investors looking to set a minimum future value for their stock. By combining the purchase of a protective put with the sale of a covered call, you can create a protective collar, offering downside protection Downside Protection Generally used in connection with covered call writing, this is the cushion against loss, in case of a price decline by the underlying security, that is afforded by the written call option. and limiting upside potential, with little or no out-of-pocket cost. Your proceeds from the sale of a covered call can offset some or all of the cost of purchasing a protective put. Some collars are specifically created as zero-premium collars, with the strike prices set at levels that result in a net zero cash outlay. To understand how all this works, take a hypothetical example. Assume it is May and an investor has a large amount of his portfolio invested in shares of XYZ XYZ interj. Informal Used to indicate to someone that the zipper of his or her pants is open. [ex(amine) y(our) z(ipper).] stock, valued at $62 per share. The investor would like to limit big losses through January, while still participating in more upside Upside The potential dollar amount by which the market or a stock could rise. Notes: This is basically an educated guess on how high a stock could go in the near future. See also: Bull, Downside moves of the stock. If the investor wanted downside protection below $55 through the end of the year, he could purchase January expiration 55-strike puts for $4 per share and sell January expiration 70-strike calls at $4 per share. This strategy "collars" the value of the stock, protecting him from a drop below $55 while limiting his upside to $70. Be sure to seek qualified investment, tax and legal advice before undertaking any of these strategies. Kortney Christensen is a high net worth and concentrated equity specialist at A.G. Edwards & Sons in St. Louis. Send questions or comments to networth@chiefexecutive.net. |
|
||||||||||||||||||
Printer friendly
Cite/link
Email
Feedback
Reader Opinion